3 Most Common Down Payment Strategies for Land Purchases

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As in nearly every industry, the entry-level conversation starts with a budget.  How much money have you earmarked for land investment? But that is usually the easy question.  Our clients know how much they have to spend.  Usually, it’s a range, but clearly, most clients have gotten this far in the process when they get to us.  The more important initial conversation revolves around preferred investment strategy.  It involves risk tolerance, position in life, predicted income.  And most often, these elements first display themselves when we discuss down payment strategies. For this exercise, let’s set aside the type of property someone wants…because 1) while that can reveal someone’s risk tolerance, that isn’t always the case and 2) we typically see no difference in down payment strategies between buyers of tillable or recreational land.  

In our experience, down payment strategies can be broken down into three main categories.  That doesn’t mean that each down payment falls 100% into one of these buckets.  In fact, most down payment scenarios are a hybrid approach.  But a confident approach comes from understanding each down payment strategy.  

Paid in Full

The easiest option to cover is a 100% down payment strategy. I am aware that this strategy is not an option for many land buyers.  And just because you can’t pay cash for a property, that doesn’t mean you shouldn’t get involved in land investing.  This strategy is most commonly used by individuals who are either in or close to retirement and individuals who have accumulated a significant amount of wealth early in life.  The thought process is simple…a land purchase using this strategy is no different than buying stock.  It is moving money from one investment to another. It diversified risk.  Typically, individuals who employ this strategy are educated on the historical performance of land values and see it as a way to decrease risk while enjoying some of their investments. 

Monthly Payment Calculation

This option typically incurs the biggest risk but also allows the investor to back into his or her exact comfort level in terms of the out-of-pocket expense.   It is the most common down payment strategy.  It is primarily used by buyers who are in the middle of their earning days.  The end numbers are different for everyone but the theory is the exact same.  The questions that you must ask yourself to begin this down payment are as follows.  

  1. How much money am I comfortable with putting down on a property?
  2. How much money am I comfortable with coming out a pocket annually to pay for the property?

The answers to these questions reveal what kind and size of the property the individual can buy.  It doesn’t back you into an exact answer, but it reveals a range of properties you can buy.  

For example, let’s say a buyer has $50,000 to put down on a potential property.  And the buyer is comfortable with coming out of pocket with $10,000 annually.  The formula for revealing potential property targets goes like this…

Expenses – Income = Net Annual Payment

Each farm has its own specific expenses and income but most commonly they are…

Expenses

  1. Mortgage Payment
  2. Property Taxes
  3. Maintenance 

Income

  1. Farm Rent
  2. CRP Payments
  3. Hunting/Fishing Leases

The easiest way to get a range of potential property targets using this method is to run the formula on a property with zero income, and then again on one with 100% tillable.  Sure, you are going to have to apply some logic to your unique situation…if you are looking specifically for a deer hunting property, you may swap out that 100% tillable property with one that has the highest percentage of tillable that you are willing to consider.  For most deer hunters, that typically falls around 50%, but the exercise remains the same.  To start this exercise, it is easiest to make some ballpark assumptions…we can fine-tune these numbers when we start looking at specific farms but this will provide us with a range of farms that fit our financial capabilities. They typically go like this…

Assumptions
– 100% Timber Property with no immediate income
– Property Tax = $1200/annually ($100 Month)
– No ongoing maintenance costs

Under these circumstances, the formula would be…

Comfortable Annual Payment – Property Taxes – Maintenance Expenses = Target Annual Mortgage Payment

For this buyer, we know the comfort zone out of pocket is $10,000. So we then plugin that amount and the assumed property taxes to reveal a mortgage amount. For a 100% timber property, we are also going to assume no ongoing maintenance expenses. 

$10,000 – $1200 – $0 = $8800

So now we have backed into an $8800 annual mortgage payment ($733/month).  Now simply run that number against the current loan climate.  For example, banks now are around 4% interest on a 30-year amortization schedule.  If you plug in those numbers on a mortgage calculator, it reveals that a $150,000 loan has an annual payment of around $8600.  

This portion of the exercise reveals that this specific buyer has a ceiling of $200,000 ($150,000 mortgage plus $50,000 down payment) when there is no income.

Now we run the same formula on a property with 100% tillable.   

Assumptions
– 100% Tillable with $9,000 annual income
– Property Taxes = $2400/annually ($200/month)
– No Ongoing Maintenance Costs

To get to some of these assumptions, we ballpark some projections based on the first portion of the exercise.  For example, if the max spend on a timber property is $200,000, we know the max spend on a 100% income property is going to be greater than the $200,000 (based on increased income).  So let’s plugin $300,000 for a 100% income property to see where that number lands in terms of annual out-of-pocket expenses.  

Assumptions
– $300,000 purchase price
– Average 3% Return (This will change based on your local return averages…chat with a local broker to get some averages in your area) = $9,000 annual income

Now let’s plug in the same formula as above…

Expenses – Income = Annual Out of Pocket Payment

Expenses
$250,000 mortage ($300,000 minus $50,000 down payment) = roughly $14,400/yr
Property Tax = $2400 (assumed)
Total = $16,800

Income
$9,000

$16,800 (Expenses) – $9,000 (Income) = $7800 annual out of pocket expense.  

These projections reveal that $300,000 is well within the buyer’s comfort zone of $10,000 annual out-of-pocket expenses.  To get an exact number, we can bump up the purchase price a bit.   

Assumptions
– $350,000 purchase price
– Average 3% Return = $10,500 annual income

Expenses
– $300,000 mortage ($350,000 minus $50,000 down payment) = roughly $17200/yr
– Property Tax = $2400 (assumed)
– Total = $19600

Income
$10,500

$19,600 (Expenses) – $10,500 (Income) = $9100 annual out of pocket expense.

This purchase price reveals that even a $350,000 purchase price on a tillable property is within the comfort zone.  In fact, there is even a touch more room there.  But we are getting pretty close…so in terms of a ballpark starting point, this buyer should target properties from $200,000 to $350,000 depending on the level of income on that specific property.  The more income, the more that buying power goes up.  

Now, clearly, each buyer can modify these numbers based on their financial position and also apply more detailed information based on the type of property they are looking for.  

Ultimately, it is these formulas that will let a buyer find a range of properties within their comfort zone in terms of out-of-pocket annual expenses.  Once you find a range of properties, you can update these formulas to each specific property to see if it is a good fit. One thing that this exercise does illustrate, is that it is significantly easier to carry property with some tillable land as opposed to all timber. Keep that in mind as you begin your search.

Pay for Itself

This down payment strategy is very common among our land investing clients and admittedly, this is our personal favorite strategy.  When buying land personally, we aim to achieve this strategy.  It has a very similar formula to the previous strategy.  It starts with identifying how much money you are comfortable putting down on a property.  Then you apply the formula above with a specific goal…to get the annual out-of-pocket expense to net zero.  Essentially, these buyers have the goal of putting down enough money on a property that it will pay for itself.  These buyers always target properties with at least some income that will be used to cover any mortgage payment.  There are several ways to back into this formula but the easiest is to first identify what type of property you are looking for. For this exercise, let’s assume this buyer is looking for a recreational property with 50% tillable  Let’s also assume the buyer has earmarked up to $100,000 as a down payment.  To start, let’s get a baseline for the ballpark purchase price this buyer should be targeting. 

Let’s make the following assumptions…

– Purchase Price = $200,000
– Income = $5,000 / annually
– Mortgage = $5750 / annually
– Property Taxes = $1200 / annually

Expenses ($6950) – Income ($5000) = $1950 annual out of pocket expense 

In this scenario, the property does not float itself but costs less than $2000/year.  So we would see that number as a good baseline.  A $200,000 purchase price gets you in the ballpark depending on the income.  So we would recommend a $150,000-$200,000 range for this buyer.  

From there, we run the numbers specifically on any property that is appealing to that buyer.  For properties on the lower end of the target range, the buyer has a little more flexibility to increase the amount they put down on the property.  On properties that are at or above the target purchase price range, that flexibility diminishes.  At the higher end of the price range, the buyer must be patient and ready to miss out on potential properties that meet their needs.  

Conclusion

Each and every buyer is different, and their approach to down payments is different.  But typically, they begin with an understanding of these three strategies.  From there, they are tailored to meet the comfort level of each buyer.  Many times the down payment strategies fall exactly in line with one of the above categories.  Many times they end up as a hybrid.  Ultimately, down payment strategies are an indication of each buyer’s risk tolerance.  The less out-of-pocket expense involved, the less risk created.  If a landowner doesn’t have to come out of pocket to carry property, the only major risk is a decrease in property income, which historically is incredibly rare.  Even then, it is relatively minor in terms of decrease and tends to be very short-lived.  So when considering buying a property, think carefully through your risk tolerance and align that with what you want in a property.  The next step is where it gets more fun – locating potential properties! 

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